The U.S. Homebuilding Industry and The Competitive ... Files/US_Homebuilding_Industry...The U.S. Homebuilding Industry and The Competitive Position of Large Builders ... Homebuilding
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
The U.S. Homebuilding Industry and The Competitive Position of Large Builders
Professor Michael E. PorterHarvard Business School
Centex Investor ConferenceNew York, NY
November 18, 2003This presentation was prepared with the assistance of Catherine Turco, Harvard Business School. It draws on ideas from Professor Porter’s books and articles, in particular, Competitive Strategy (The Free Press, 1980); Competitive Advantage (The Free Press, 1985); “What is Strategy?” (Harvard Business Review, Nov/Dec 1996); “Strategy and the Internet” (Harvard Business Review, March 2001); and a forthcoming book. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means —electronic, mechanical, photocopying, recording, or otherwise—without the permission of Michael E. Porter. Additional information may be found at the website of the Institute for Strategy and Competitiveness, www.isc.hbs.edu.
The Economic Foundations of Competition Basic Economics of Strategy
0%
5%
10%
15%
20%
25%
30%
Pharmacia & Upjohn* Southwest Airlines
Return on Invested Capital
1985-2002
19.55%
12.75%
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)* Prior to 1995, reflects Pharmacia only. Company was acquired in 2000 by Monsanto, which then changed its name to Pharmacia
The Economic Foundations of Competition Basic Economics of Strategy
0%
5%
10%
15%
20%
25%
30%
Pharmacia & Upjohn* Southwest Airlines
Return on Invested Capital
1985-2002
19.55%
12.75%
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)* Prior to 1995, reflects Pharmacia only. Company was acquired in 2000 by Monsanto, which then changed its name to Pharmacia
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations
Profitability of Selected U.S. Industries
Average of the U.S. Economy: 11.6%
Return on Invested Capital, Average of 1985 – 2002
Differences in Profitability Within Industries1985-2002
0% 10% 20% 30% 40% 50%
Intel
Micron
TexasInstruments
JDS Uniphas
LSI Logic
NationalSemiconductor
AdvancedMicro Devices
Average Return on Invested Capital, 1985 - 2002
Semiconductor Industry Airline Industry
0% 10% 20% 30% 40% 50%
Southwest
Northwest
Delta
AMR Corp
Continental
UAL Corp
US Airways
Average Return on Invested Capital, 1985 - 2002
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations. Large Builders include BZH, CTX, DHI, HOV, KBH, LEN, MDC, MHO, NVR, PHM, RYL, SPF, TOL, WCI.
Return on Invested Capital, Average of 1985 – 2002
Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations
Note: Equation of the trendline: y = 0.0009x - 1.5887; R2 = 0.0304Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations. Large Builders include BZH, CTX, DHI, HOV, KBH, LEN, MDC, MHO, NVR, PHM, RYL, SPF, TOL, WCI.
Large Builders Best Fit Trendline
Trends in Industry ProfitabilityLarge Public Homebuilders
Note: Equation of the trendline: y = 0.0053x - 10.483; R2 = 0.3369Note: ROIC calculated as EBIT divided by Average Invested Capital (Total Assets less Excess Cash less Current Operating Liabilities)Source: Compustat and author’s calculations. Large Builders include BZH, CTX, DHI, HOV, KBH, LEN, MDC, MHO, NVR, PHM, RYL, SPF, TOL, WCI.
Large Builders Best Fit Trendline
Trends in Industry ProfitabilityLarge Public Homebuilders
(-) Buyers can purchase an existing home or rent (-) Buyers can improve their current home
Capital(-) Builders rely on funding from banks on a
project-by-project basis; banks have historically withheld funding in downturns
Land(+/-)Land purchase and entitlement are local
activitiesLabor(+/-) Labor is supplied by local/regional
subcontractorsMaterials(+/-) Most materials are purchased from local
or regional suppliers
(+) No foreign competition(-) Lack of inventory discipline in the market
leads to excess supply and competition on price
(-) Lack of capital market discipline leads to overbuilding and competition on price
(-) There are thousands of builders in the US, all of which are small, local or regional players
(+) Homes are differentiable as products, especially in certain segments
(-) Many features are easily copied(-) Homes represent a major expense for
buyers, making them concerned with price
(-) Affordability is a main driver of demand and pricing and is a function of macro factors (e.g., interest rates and unemployment)
(-) Barriers to entry are low- Up-front capital costs and other barriers are not significant enough to stop entry- Labor subcontracting and materials procurement are local activities
Capital• S&L crisis has led to improved capital market
discipline
Land• Land is increasingly scarce in desirable
markets• Entitlement is an increasingly complex and
lengthy process in many markets
Materials• Materials procurement is becoming more
regional and national, not just local
• No foreign competition• Consolidation of the industry• Growing share held by large public homebuilders• Large builders provide greater inventory discipline
in the market• Larger home builders are competing directly in a
growing number of markets
• Land/location become important differentiating factors, not just features of the house itself
• Barriers to entry are rising- The complexity of development is increasing, especially for large projects- Economies of scale in capital access are growing- Economies of scale in materials procurement are growing
Barriers to entry
Bargaining Power of Buyers
• Average returns should be stable or trend upward
• Long-term fundamental demand for new housing remains solid- Population growth is the primary driver of long-term demand- The real income and age of households are secondary drivers
Competitive Advantages of Large BuildersAccess to Capital
• Small builders can access only bank credit
– Access to bank credit is limited or dries up in economic downturns
– At certain points in the economic cycle, however, the cost of short term bank debt may be less than that of corporate bonds with longer maturities
• Large builders can access both bank debt and corporate bonds
– Use of both bank credit and corporate bonds together provides a less volatile source of capital than bank credit alone
– Over the long-term, the cost of debt for large builders with public market access is likely to be lower than for smaller builders with access to bank credit only
• Large builders enjoy superior, more reliable capital access than smaller builders
Competitive Advantages of Large BuildersLand Supply
No statewide mandate but Urban Growth Boundaries actively pursued locally(33 Urban Growth Boundary ballot measures from 1994-2000, nearly all of which passed)
California
Smart Growth Act (1996) enables counties to establish Urban Growth Boundaries; most urban counties have done so.
Maryland
Growth Management Act (1990) requires large, urban counties and cities to develop growth plans, align zoning requirements, and establish Urban Growth Boundaries. (29 of 39 counties participate)
Washington
Growth Management Act (1973) requires comprehensive plans and Urban Growth Boundaries. All cities and jurisdictions had established growth boundaries by 1986.
Oregon
Growth Management Act (1985) requires comprehensive, coordinated growth plans at state, regional and local levels.Urban Growth Boundaries optional. All metropolitan counties compliant by 1990.
Florida
Note: Urban Growth Boundary = a set of land-use regulations that prohibit urban development outside a certain boundarySource: Staley and Gilroy, “Smart Growth and Housing Affordability: Evidence from Statewide Planning Laws”, Reason Public Policy Institute, 2001
Anderson, “Use and Implementation of Urban Growth Boundaries”, Center for Regional and Neighborhood Action, 1999Pendall and Martin, “Holding the Line: Urban Containment in the United States”, Brookings Institution Center on Urban and Metropolitan Policy, 2002
Examples of Statewide Growth Management
• Regulation limiting the amount of developable land is increasingly prevalent in many major markets
Competitive Advantages of Large BuildersLand Supply - Continued
Source: California Department of Housing and Community Development, Raising the Roof: California Housing Development Projections and Constraints, 1997–2020, Exhibit 15. Capacity = (suitable land acreage) / (1996 housing density), by county. Suitable acreage excludes developed land, publicly owned land, underwater acreage, land with slope > 15%, wetlands, prime and unique farmlands, Q3 floodzones , and areas most suitable to large numbers of endangered species .
Southern California Coast2.5 million units
S.F. Bay Area1.7 million units
• Land shortages are heavily due to regulation, not just to a lack of available land
Market Assessment versus Sustained ProfitabilityIndustries in the S&P 1500 Universe
Price/Book v. ROIC1991 - Present
1
2
3
4
5
6
5% 10% 15% 20%Average ROIC
Ave
rage
Pri
ce/B
ook
HomebuildingReal estateoperations
Gold and Silver
Motion pictures
Broadcast and Cable
Recreational Activities
Biotechand Drugs
Appliances and Tools
Metal Mining
Misc. Transportation
ComputerServices
ComputerNetworks
Mobile Homes and RVs
Note: Universe includes S&P 1500 companies, excluding util ities and financial services. Industries with ROIC>20%, ROIC<5%, or P/B>6 not shown.Note: ROIC calculated as EBIT / Average Capital. Median for S&P 1500 companies in industry. Source: FactSet.
Standard Deviation of Year-Over-Year Change in ROIC
0200400600800
1,0001,2001,4001,6001,8002,000
Office Eq
uipment
Hotels &
Mote
ls
Real E
state
Operati
ons
Bever
ages
(Non-Alc
oholic
)
Rental
& Lea
sing
Conglo
merates
Textile
s - Non
Appa
rel
Home B
uilders
Paper
& Pa
per Pr
oducts
Restau
rants
Waste M
anag
emen
t Serv
ices
Recrea
tional
Activitie
s
Chemica
l Man
ufactu
ring
Misc C
apital
Goods
Applia
nce &
Tool
Contain
ers &
Packa
ging
Perso
nal &
Househ
old Pr
ods
Food
Proc
essin
g
Misc Fa
bricate
d Prod
ucts
Broad
castin
g & Cab
le
Railroa
ds
Tobac
co
Major D
rugs
Constr
& Agric
Mach
inery
Trucki
ng
Appa
rel/Ac
cessor
ies
Aeros
pace &
Defen
se
Auto
& Truc
k Part
s
Iron &
Steel
Auto &
Truck
Manu
facture
rs
Metal M
ining
Fores
try & W
ood Pr
oducts Reta
il
Casino
s & Gam
ingFoo
twear
Office Su
pplies
Electro
nic Ins
tr & Con
trols
Perso
nal Se
rvices
Printing
& Pu
blishin
g
Compu
ter Pe
riphera
ls
Oil Well
Servic
es & E
quipm
ent
Healthc
are Fa
cilities
Chemica
ls - Pl
astics
& Rub
ber
Mobil H
omes
& RVs
Furnit
ure &
Fixtur
es
Constr
- Sup
plies &
Fixtu
res
Recrea
tional P
roduc
tsSc
hools
Biotec
hnolo
gy & D
rugs
Compu
ter Sto
rage D
evices
Oil & G
as Ope
ration
s
Scien
tific &
Tech
nical I
nstr
Compu
ter Hard
ware
Commun
ication
s Equ
ipmen
t
Compu
ter Se
rvices
Compu
ter Netw
orks
Medica
l Equ
ipmen
t & Su
pplies
Semico
nduct
ors Airline
Secur
ity Sy
stems &
Servic
es
Softw
are &
Progra
mming
Commun
ication
s Serv
ices
Adver
tising
Busin
ess Se
rvices
Constru
ction S
ervice
s
• Homebuilder ROIC is highly stable in comparison with other industries
Note: Universe includes S&P 1500 companies. ROIC defined as EBIT / Average Capital. Standard deviation of year-over-year change in ROIC (basis points) calculated for each company for each month from 1992 to date. Data then aggregated by industry by taking mean of the standard deviations calculated for each company in the industry. Excludes utilities, financial service companies, and industry groups with fewer than 5 companies.
• Investors often reward growth at the expense of sustained profitability
• Investors fixate on highly visible but short-term demand influences such as interest rates and overall housing starts rather than structural determinants of long-term profitability
• Investors and analysts create strong pressures for companies to emulate the practices of “successful” peers, or “do deals” (M&A)
– Reinforce imitation instead of distinctive competitive advantages
• Investors and analysts should pay more attention to the structural attractiveness of a company’s industry and its sustainable competitive advantages versus cyclical fluctuations and short-term trends